Chapter Eighteen Mutual Funds

Overview n A mutual fund is a pooled investment portfolio with many different investors (shareholders) managed by a professional manager. n There are over 8000 mutual funds managing over $12 Trillion in assets as of November n Mutual funds account for just under 20% of total household financial assets and approximately 50% of people own mutual funds. n Approximately 55% of mutual fund assets are held in stock market mutual funds.

Advantages/Disadvantages of Mutual Funds n Diversification n Professional Management n Time Savings n Selection n Performance n Expenses

Structure of Mutual Funds n Open-End Mutual Fund n Closed-End Mutual Fund n Exchange Traded Fund (ETF)

Mutual Fund Objectives n Money Market Mutual Funds n Bond Funds n Equity Funds n Hybrid Funds n Specialty Funds n International Funds

Mutual Fund Expenses n Load Charges – A fee charged at the time of purchase designed to compensate sales agents. n Expense Ratios – An annual charge (taken daily) to cover the costs of managing the mutual fund and to generate a profit for fund management. n 12b-1 fees – An annual fee taken from the fund to compensate sales agents and provide services for shareholders. n Share Classes –Class A – Front-end load charge and may have small 12b-1 annual fee. –Class B – No front-end load, higher annual 12b-1 charges, and a Contingent Deferred Sales Load (declining back-end load charge). Typically convert to A shares after 6-8 years. –Class C – No front-end load, higher annual 12b-1 charges, does not convert to A shares. n Estimating true cost of various expenses – See handout and spreadsheet.

Information on Mutual Funds n Yahoo Finance n Moneycentral n Value Line n Prospectus n Fund Families

Hedge Funds n According to Hedgefunds.net, it is estimated that hedge funds managed $2.7 trillion as of the end of the third quarter in n Less regulated than mutual funds and can use more specialized (and sometimes risky) strategies. n Typically have significantly higher expenses. n Restricted to high net worth individuals and institutions.

Homework n Q 1-5, 11, 13, n P 1-2, 4, 8, 10 n You are planning to invest $200 per month into one of three mutual funds. Mutual Fund A has a 5% load charge and a 0.5% annual expense ratio. Mutual Fund B has no load charge and a 1.25% annual expense ration. Mutual Fund C has no load charge and a 0.5% annual expense ratio. If your investment horizon is 4 years and you anticipate a 9% rate of return (compounded monthly), what is the total cost (in $) for each of the 3 funds. What if your investment horizon is 35 years? n Discuss under what types of investor horizons class A shares would be preferred to class C shares for a mutual fund investor? How about a situation where class C shares might be preferred? n Explain how a fund with low turnover may be better than a fund with high turnover. n Consider a strategy where an investor reallocates his wealth each year to put 20% of his investment portfolio into each of the top 5 performing mutual funds from the previous year. Is this likely to be an effective strategy? Explain. n Explain the difference between a hedge fund and a mutual fund.